By Dan Mikes

Regardless of your church’s rate of growth, you’ll ultimately be forced to weigh your current and anticipated needs against the realities of your capacity and willingness to service debt. This is a critical juncture: Such a question will prompt a philosophical debate, the outcome of which might well determine whether your future facilities will serve the needs of the ministry, or whether the ministry will end up serving the financial consequences of the additional buildings.

The ultimate design and configuration of the proposed new buildings is the product of much prayerful deliberation about numerous unique factors, including ministry objectives, age and income demographics, land and access limitations, and more. Often, churches defer focused discussion regarding the means of funding the desired improvements until after the design concept has gathered considerable momentum.

Capital fund-raisers are solicited to submit their competing perspectives regarding an achievable pledge target. Finally, attention turns to the lender. Church leaders want to sustain the momentum of the 36-month pledge campaign by setting its start date no earlier than two to four months prior to the signing of loan documents and the breaking of ground. Given the construction duration of only 12 to 18 months, is there enough borrowing capacity to bridge the cost of the desired facilities with the timing and availability of equity dollars? If the first lender’s answer is no, should the church press on in search of a more aggressive bank willing to flatter the church with a commitment for as much debt as possible?

The answer to the last question would seem obvious enough; however, when subjected to the pressures of the momentum of this process, many churches are lured down the path of excessive debt.

Churches should realize — particularly in slow economic times — that banks are under pressure to make loans. For-profit businesses might not be expanding, and lenders might be willing to venture into unchartered lines of business. Don’t let your church be the guinea pig: Seek the safety that comes from a multitude of qualified counsel.

Even some “experienced” church lenders will advise that debt levels aren’t excessive until the required annual debt service exceeds 30 percent of the church’s operating budget. This is very simplistic; bank loans typically balloon or mature in five to seven years. Given typical amortization durations of 20 to 25 years, there will still be a lot of principal outstanding at maturity. Interest rates might be higher at that point in time. Annual debt service might have begun at 30 percent of budget, but might increase to between 40 percent and 45 percent if interest rates move back to their historic averages.

Over the past two to three years, many churches have borrowed aggressively during a period of extremely low interest rates.These churches and their bankers are now anxiously awaiting the realization of their growth projections.

The Bible teaches us to “be anxious for nothing.” Churches would be best served to establish a comprehensive viewpoint and methodology for identifying an appropriate limit of indebtedness before architects are interviewed or facilities wish lists are developed. Notwithstanding the uniqueness of each church — its vision and financial means — a common methodology can and should be employed.

The best method for planning the church’s financial future is to begin with some observations of the past. A church business administrator should supply the building committee with a simple spreadsheet illustrating three to four years of historic summary financial information.

Begin by arranging the first year’s information in the first vertical column, and then add subsequent years to subsequent columns. Your spreadsheet can be limited to seven lines of data, including net income, interest expense, depreciation, non-recurring expenses, total debt-service capacity, proposed annual debt service and debt-coverage ratio.

The objective of the spreadsheet is to illustrate the church’s historic capability to service the proposed or future debt load. For example, net income + interest expense + depreciation + nonrecurring expenses might indicate total debt-service capacity of $300,000. If the level of contemplated debt would require proposed annual debt service of $400,000 per year, the debt-coverage ratio for that year would be .75:1. To allow for unforeseen interest-rate fluctuations, be sure to use a slightly-higher-than-current-market interest rate when calculating the proposed annual debt service.

Churches which have not carried debt in recent years typically demonstrate deficient historic debt-coverage ratios ranging from .5:1 to .75:1. Given their nonprofit objective, banks generally don’t expect churches to meet the 1.2:1 or better standard to which for-profit businesses are held. The church will simply need to identify the proposed means of transitioning the operating budget going forward so as to achieve a 1:1 coverage ratio or better.

Most churches use a 36-month capital pledge campaign to aid in this transition. How the church defines “aid” will serve to identify its risk tolerance. Should the post-construction pledge receipts be sufficient to simply cover the debt-service shortfall, or should they also enable significant acceleration of principal reduction? In other words, by the end of the pledge campaign, will the debt have been reduced to a level that will elevate the pre-campaign historic debt-coverage ratio to 1:1 or better?

A conservative church leader will answer the last question in the affirmative. In so doing, he or she is declaring the debt will be limited to a level which will be serviceable, without having to bet on future growth or to impose upon the membership a perpetual cycle of capital stewardship campaigns.

This might result in a decision to divide the facilities wish list into two or more construction phases. While the construction cost inefficiencies associated with phasing won’t be fully offset by the reduced interest expense associated with a lower debt burden, one can’t overstate the value of peace of mind.

Dan Mikes is the senior vice president of Bank of the West in Walnut Creek, Calif. For more information, call 800.405.2327 or visit www.bankofthewest.com/churchlending.